Wednesday, August 7, 2013

When the market calls a spade a spade

I posted this on Karl Denninger's Market Ticker on this date. 

There are some stupid questions asked in regard to money, no offense intended.

For one thing, the banks would remove every spare dime from the Fed. Depositors would remove every dollar they could stand to hide themselves from the banking system and hold it in cash. They can't turn your currency into 99 cents from one dollar and issue 99 dollar bills in place of $100's. Banks would be devoid of currency and cease to function.

In a sense, the central bank is already carrying on a negative interest rate policy. The interest rate, which is basically zero, up to 1/2%, if you take into consideration what the Fed is paying on excess reserves. A real interest rate encompasses at least the inflation rate and should encompass a return in excess of that. The rate is near zero because Benny has put so much money in the system the banks don't need money to clear their imbalances.

There is a big joke out there the Fed can tomorrow declare the interest rate to be 1%. Benny has ass fucked himself with all his QE. He has to create enough of a shortage to create a bid for bank funds. Remember, Fed money has to do with the transition of bank liabilities and has little to do with our accounts. The banking system pays interest on the cash we hold, at least indirectly. In truth it is paid by the government, but is forfeited by the banks, in that they hold non-interest bearing Federal Reserve liabilities in lieu of interest bearing treasury debt.

Maybe in the long run, things are the way we think they are, but in the short run, the system works entirely different than the vast majority of us were taught. It is the function of a credit system, which is really a debit and credit system. The cash available at any given time to those outside the bank consists of credits or bank liabilities and currency held by the public. Few, if any businesses, outside of retailers and illegal businesses hold any significant balances of currency outside the banks. Retailers hold only enough to make change for what comes into their trade and the vast majority of other cash is held by businesses that cash checks.

The actual print has been around $1 billion a week, from figures I see Doug Noland publish on his weekly report on money supply. The remaining $80 billion plus is ending up, largely on the debit side of the bank ledger, plus whatever is being financed directly by government flows. It is these government flows, money that it is implied by decades of action as money that will never be paid back and backed by compound interest that is the true long term push on inflation. KD's example of borrowing against future demand is the counter balance of private money expansion. Thus, out of the banks assets (ie: bonds you and I sell that are funded by the Fed, along with those bought from pension funds and other institutions) make up the bulk of credit creation by the Fed. Credit creation implies there is a credit entry creating a cash liability on the bank ledger.

I think the primary effect of QE is more and more, a greater and greater percentage of the bank assets are represented by Fed money. This is in effect, a forced deleveraging of the various banks balance sheets. A creation of a mass of idle capital and an unwinding of the long term leveraging of debits the banking system has accomplished over decades. There may or may not be a countering credit liability, other than bank capital that represents this increase. For years, banks have been creating credits on a very minimal increase in bank cash, literally their entire portfolio being represented by loans and various income producing assets, against a small slice of capital.

Bank credits can be extinguished by the repayment of debt that extinguishes bank debits. Such an action on Fed funds can only be exercised by a resale of assets by the Fed, picking up cash or payment of interest to the Fed. This interest generally cycles back through the Federal government and paid back out into the banking system, producing a wash. Thus, the only thing that can carry this cash is private capital. It can't go anywhere, except to be used to leverage more credit, which is actually leveraged against bank capital, be withdrawn from the bank for cash hoards or lie there in the banks. Very little bank lending is used to create a hoard of currency, but instead is used to move to credits in the bank issuing the credit or in other banks in other entities accounts.

It is what is happening to the cash, once it is created that presents the current picture. The debt levels and the structure of the US economy is now that money might flow to entitlements, but the money spent by those drawing entitlements circulates mainly to accounts where it isn't being spent again through the economy. Any flow merely creates a cash balance somewhere else. Corporate profits are now around 1/8th the economy, up from a long term average of 1/16th, so in short it takes money only 8 cycles to belong totally to the corporate world, as opposed to 16 times years ago. Much money is being used to pay interest on prior debt, thus accruing to accounts that reinvest the money. Unlike the average Joe, these entities don't spend their entire cash hoard every 2 weeks, but buy assets with it instead. Money instead is being used for speculation instead of consumption. Some is being used to replace worn out capital goods, but little is being used for expansion, because demand has been pulled forward.

Japan is an interesting study, in that everything that would be assumed to happen, hasn't happened. The US is on QEIII. Japan is on QE a whole lot more. Their government carries a massive debt, I would suspect largely monetized by the Bank of Japan. The banking system in Japan is so full of cash, the people of Japan, having received next to zero on their funds are holding hoards of printed yen, in lieu of the banking system and still little pulse. At best, one can speculate on wide swings in the Nikkei index and hope to beat the game. The fact Japan hasn't blown up YET, is evidence this game works. The fact Japan's economy has stagnated, their birth rate has collapsed and their debt is massive, is evidence trouble is still ahead of us. Abe is going to prove the point one way or another.

The fiat on US currency reads "This Note is Legal Tender for all Debts, Public and Private". The currency is a unit of debt, valued only in its capacity to satisfy debt obligations. This is why the dollar has international value. The fact the dollar once had intrinsic domestic value, that it was part of the international gold exchange system and represented stored capital, made it a means of transferring capital and debt between countries. It is through the international banking system that trade is generally transacted and international debt is created. The dollar has value internationally, not because the US prints it, but because massive banking and other debts are denominated in dollars. It is also the means of access to the United States capital markets, the deepest in the world. It is the unit of trade, not due to decree, but due to its position in debt in capital markets around the world. Regardless of whether a country would issue gold back currency, gold itself or choose another currency, the fact is that the fiat of tender for debts around the world give rise to its value and not much of anything else.

In the position of debt and in the position of credit in banking around the world, the value of the dollar is also the problem with the dollar. This along with the fact that principal and interest in banking can only be satisfied with the creation of more dollars, not on the banks ledger, but in the accounts of those that owe dollars in the form of principal and interest to the banks. The banking system creates every actual dollar in existence. Dollars are loaned through other entities, but they are only created through borrowing from commercial banks and monetization of sovereign debt.

If you do the math, we get back to what Karl wrote above. I buy a car with cash from my account, the cash goes to another entity and I get the car. Once I move from paying cash to creating a debt instrument, either a bank creates the cash or the cash is acquired from the banking system as a loan or from an account and placed into another account. I no longer own my car until it is paid off and to get another one, I either have to take out a new loan or save the money while I am paying off the car I have to buy another at cost beyond the equity I have in the car I own. This problem began to assert itself back in the 1970s, when terms on auto loans was extended beyond the 36 month terms that were usual then. I think they now have auto loans of 7 years and maybe longer and leases where no equity is acquired. People roll larger and larger balances to the next auto, to the point they no longer can trade cars. Of course, in order to continue to lengthen the term of loans, automakers had to make better cars. When I was a kid, a car with 100,000 miles was considered an exceptional auto that was worn out and had little trade value. Today, if I bought a car that wouldn't go 200,000 miles, I would consider it a lemon. I am now at 93,000 miles on a truck I bought used 6 years ago, a total of 173,000 miles. I recall in the 1980's, a 6 year old auto was a pile of junk. Mine will be 14 model years on and I expect to drive it 2 more years. You couldn't do that in 1980, nor could a lender expect to have a car worth much more than scrap at the end of a 5 year loan. Autos are one thing that I can about guarantee you they don't make them like they used to and thank God they don't.

Credit cards are another matter. I would suspect a person who has required debt service on credit cards in excess of 10% of their income are credit impaired. They are also debt slaves. In order to extinguish credit card debt, a persons spending must not only decline the amount it exceeded income while the debt was being incurred, but a like amount, plus interest must be dedicated to paying down the debt. Thus, if a person paid interest only on their $10,000 line of credit over 50 months of building up the debt, their cost during that time was the interest. Their incurring of debt was $200 a month, spending they did in excess of income minus interest. Going from spending $200 a month more than someone makes to spending $200 a month less is a $400 swing. It is either do that, pay on the debt forever or default. Bankruptcy solves a lot of these problems, as long as the system is set up to absorb the losses.

One persons money debt is another persons or institutions money asset. The impact of default, on a wide scale basis, is loss in many areas, including banking. I don't believe there is any purpose for what the Fed has been doing other than to cover up insolvency in banks, pension funds and strangled leveraged plays. As we go forward, more supposed wealth accrues in these areas,, until the markets catch up and once again declared a spade a spade.

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